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An Analysis of Section 45(4) as amended by the Finance Act – 2021 on reconstitution of Partnership Firm
While presenting the budget -2021, the proposal was there just to replace section 45(4) and introduce section 45(4A). However, drastic changes have been done at the time of passing the bill and new section 9B & 45(4) have been added by dropping section 45(4A).
It is important to understand that when a partner retires from the firm and obtains money or property from the firm, there are two transactions.
First one, qua the partner and
Second one, transfer of money or property by the firm.
The former transaction is dealt with in section 45(4) and the later in section 9B. New Section 45(4) now provides for taxation if the partner receives the “capital assets” or “money“ at the time of reconstitutions whereas Section 9B covers situation where the partner receives capital assets or stock in trade at the time of reconstitutions or dissolution.
An Analysis of the Provision of Section 45(4):
Section 45(4) applies if the following conditions are satisfied:
- The provision is applicable only if there specified person & a specified entity. The provision applies when a specified person ‘receives’ a capital asset or stock in trade.
- Specified person – “Specified person” means any one of the following
(a) a person who is a partner of a firm (b) a member of any AOP (c) a member of any BOI.
- Specified entity – “Specified entity” means a firm or other association of persons or body of individuals (not being a company or a cooperative society).
- The provision is applicable only if on “Reconstitution” of the firm and not on “Dissolution” of the firm.
- The tax impact will arise if the specified person receives
- any capital asset, or
- money, or
- No tax implications arise under this section if the stock in trade is received by the partner on reconstitutions.
- Any profits or gains arising from such receipts by the specified person shall be chargeable to income-tax as income of such specified entity under the head “Capital gains”.
- The profits and gains shall be deemed to be the income of such specified entity of the previous year in which such money or capital asset were received by the specified person.
- Profits or gains shall be determined in accordance with the following formula, namely:
A = B+C-D
A = income of the specified entity chargeable under the head “Capital gains”;
However, if the value of ‘A’ in the above formula is negative, ‘A’ shall be deemed to be zero:
B = value of any money received by the specified person from the specified entity on the date of such receipt;
C = the amount of fair market value of the capital asset received by the specified person from the specified entity on the date of such receipt; and
D = the, amount of balance in the capital account (represented in any manner) of the specified person in the books of accounts of the specified entity at the time of its reconstitution:
For the purpose of D, the balance in the capital account of the specified person is to be calculated without taking into account the increase in the said account due to revaluation of any asset or due to self-generated goodwill or any other self-generated asset [proviso to section 45(4)].
- The section is applicable notwithstanding anything contained in section 45(1). Section 45(4) starts with the expression “notwithstanding anything contained in sub-section (1)”. Thus, it overrides section 45(1). In other words, if there is any conflict or inconsistency between section 45(1) and section 45(4), the latter provision will prevail.
- Receipt of stock by the specified person from specified entity i snot all relevant for the purpose of Section 45(4).
- If there is a loss in computation while computing income u/s 45(4), it is required to be ignored. The benefit of adjustment or carry forward will not be available in such case.
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